Wednesday, March 5, 2014

Where Baby Hedge Funds Come From

A recent study finds that a significant number of hedge funds launched last year received seed capital, but no new fund sought investments through advertising.

The study by Seward & Kissel, a law firm, found that some 40% of 2013 hedge fund rollouts greater than $75 million (about 15% of all fund launches) obtained seed capital.

In addition, 43% of funds in the study had some form of founders' capital.

The study said prominent new firms entered the seeding arena in 2013, joined by several smaller opportunistic one-off investors, such as family offices and high-net-worth individuals.

Seed investments in many of the bigger deals tended to be in the $75 million to $150 million range, typically with a two- to three-year lockup. Smaller deals, usually with less well-known managers, generally attracted seed capital in the $10 million to $50 million range.

No fund in the study engaged in general solicitations and advertising, which is now permitted under the JOBS Act by Securities Act Rule 506(c).

Seward & Kissel said its study covered the 2013 hedge fund launches sponsored by U.S.-based managers that were its clients. It said the number of funds was “large enough to extract a representative sample of important data points that are relevant to the hedge fund industry.”

Other Findings

The study found that 65% of new funds examined deployed equity or equity-related strategies, about the same as in the firm’s 2012 study.

Of the remaining non-equity funds, about 12% were multistrategy/macro offerings, approximately 8% were credit or CTA strategies and the rest consisted of other strategies.

Management fees were on average higher for non-equity strategies than for equity ones: 1.825% versus 1.58% (down from 1.95% and 1.67% in the 2012 study). This rate differential, Seward & Kissel said, was due primarily to the higher overhead typically needed to implement many non-equity strategies.

Incentive allocation rates continued to be pegged at 20% of net profits across all strategies, according to the data.

The study found that 89% of funds permitted quarterly or even less frequent redemptions, while only 11% allowed monthly redemptions in 2013 — down from 36% of funds in 2012. Moreover, 85% of all funds had some form of lock-up, up from 58% in 2012.

Sponsors of both U.S. and offshore funds set up master-feeder structures more than 90% of the time, generally utilizing the Section 3(c)(7) exemption.

Most offshore funds were established in the Cayman Islands, although other jurisdictions, such as Bermuda and the Bahamas, sought to reestablish their respective presences in the industry, according to the study.

In addition, the stated minimum initial investment was set at $1 million in approximately 70% of the funds. Ten percent of the funds had a $250,000 minimum, and 20% of the funds required a hefty $5 million or more.